Have you heard this before: "Can you produce another forecast for the balance of 2009 taking into account the fluctuation of the exchange rate in Indonesia, the current price of tea in China and the number of wildebeests that migrated across the Serengeti last month?" If a prospective VC investor says something like that to you, run. He doesn't get it. And as the saying goes, "He's just not that into you."
I've seen thousands of financial plans for young startups. I can assure you--with 100 percent certainty--that they are never correct. A great entrepreneur can usually (but not always) manage the first year or two of the expense plan. However, I've never met an entrepreneur who can predict the revenue plan, especially in cases where he's starting from a revenue base of zero.
A rational VC investor knows that an early-stage financial plan is going to be wrong. He's not looking for a correct number; rather, he's looking to see how you think about your business. Your operating model and forecast should be structurally correct, contain the right elements of revenue and expenses, have a logical cash-flow model that is linked to the type of business you have, and put forth a clear set of assumptions that drive the growth of the business. However, the final numbers aren't what counts--it's your understanding of the different pieces and how they interact.
My favorite early-stage entrepreneurs are the ones who can explain their business on a whiteboard. They don't need a 42-page Excel spreadsheet that never paginates quite right when you print it to guide them. They don't need a CFO or other finance person to explain the intricacies of their model. They don't assume I can read eight-point text projected on a screen 15 feet away. They just know their business and can speak eloquently about how they think it's going to work.
Now, if you're a later-stage company that has at least five years of operating history, the historical financials and forecasting models will have more importance and a higher degree of relevance. Note that I said relevance, not predictability. As anyone who has tried to manage a business through the current downturn knows, there are some factors you can control (such as your expenses) and many you can't (such as whether or not your customers have any money to spend with you). If you focus on the things you can control and explain clearly the things you can't, your model will always be a better one.
When you're raising money and your prospective venture capitalist asks for the seventh iteration of your financial model, ask him specifically what he's trying to understand. Try to engage in a conversation that helps you figure out his concerns and helps him know that you really do understand the economics underlying your business. If he's not willing to do this, he's probably not that into you.
Brad Feld has been an early stage investor and entrepreneur for more than 20 years. He is a co-founder of Foundry Group, an early stage VC firm. Brad blogs at feld.com and askthevc.com, runs marathons and lives with his wife and two golden retrievers in Boulder, Colo., and Homer, Ala.